Foreign Direct Investment – Page 17

Arbitrage Theory

by indiafreenotes24/11/202011/01/20250

Arbitrage pricing theory (APT) is a multi-factor asset pricing model based on the idea that an asset’s returns can be predicted using the linear relationship between the asset’s expected return and a number of macroeconomic variables that capture systematic risk. It is a useful tool for analyzing portfolios from a value investing perspective, in order to identify securities that may be temporarily mispriced.

In finance, arbitrage pricing theory (APT) is a general theory of asset pricing that holds that the expected return of a financial asset can be modeled as a linear function of various factors or theoretical market indices, where sensitivity to changes in each factor is represented by a factor-specific beta coefficient. The model-derived rate of return will then be used to price the asset correctly the asset price should equal the expected end of period price discounted at the rate implied by the model. If the price diverges, arbitrage should bring it back into line. The theory was proposed by the economist Stephen Ross in 1976. The linear factor model structure of the APT is used as the basis for many of the commercial risk systems employed by asset managers.

Assumptions in the Arbitrage Pricing Theory

The Arbitrage Pricing Theory operates with a pricing model that factors in many sources of risk and uncertainty. Unlike the Capital Asset Pricing Model (CAPM), which only takes into account the single factor of the risk level of the overall market, the APT model looks at several macroeconomic factors that, according to the theory, determine the risk and return of the specific asset.

These factors provide risk premiums for investors to consider because the factors carry systematic risk that cannot be eliminated by diversifying.

The APT suggests that investors will diversify their portfolios, but that they will also choose their own individual profile of risk and returns based on the premiums and sensitivity of the macroeconomic risk factors. Risk-taking investors will exploit the differences in expected and real returns on the asset by using arbitrage.

The arbitrage pricing theory was developed by the economist Stephen Ross in 1976, as an alternative to the capital asset pricing model (CAPM). Unlike the CAPM, which assume markets are perfectly efficient, APT assumes markets sometimes misprice securities, before the market eventually corrects and securities move back to fair value. Using APT, arbitrageurs hope to take advantage of any deviations from fair market value.

However, this is not a risk-free operation in the classic sense of arbitrage, because investors are assuming that the model is correct and making directional trades rather than locking in risk-free profits.

Arbitrage in the APT

The APT suggests that the returns on assets follow a linear pattern. An investor can leverage deviations in returns from the linear pattern using the arbitrage strategy. Arbitrage is the practice of the simultaneous purchase and sale of an asset on different exchanges, taking advantage of slight pricing discrepancies to lock in a risk-free profit for the trade.

However, the APT’s concept of arbitrage is different from the classic meaning of the term. In the APT, arbitrage is not a risk-free operation – but it does offer a high probability of success. What the arbitrage pricing theory offers traders is a model for determining the theoretical fair market value of an asset. Having determined that value, traders then look for slight deviations from the fair market price, and trade accordingly.

Arbitrage Pricing Theory

The Formula for the Arbitrage Pricing Theory Model Is

E(R)I =E(R)z+(E(I)−E(R)z) ×βn

where:

E(R)I =Expected return on the asset

Rz=Risk-free rate of return

βn=Sensitivity of the asset price to macroeconomic

factor n

Ei=Risk premium associated with factor i

Corporate Directors, CEOs, Expatriates and Executives

by indiafreenotes15/11/202020/10/20240

One of the major issues that gained attention after the 2007 and 2009 financial crisis due to Wall Street movement was the unduly high compensation being paid to executives of financial institutions even when the corporations were in a state of collapse. This movement against the executive remuneration gained momentum throughout the world. In U.S and many other countries there was a lot of hue and cry about excessive compensation being paid to top executives. Even though in India the situation regarding excessive executive remuneration has not reached alarming levels yet this issue needs to be taken seriously at this stage itself. If not given proper attention then it is not long enough when this problem would be quite glaring in India too.

Many recent corporate frauds such as Satyam fraud, Kingfisher’s fraud and many others have brought into light the dark side of Indian corporate governance practices. In almost all these frauds the executives were drawing a huge salary from the company at the expense of other stakeholders of the company be it shareholders or creditors etc.They used tricks to defraud the investors as well as creditors. Thus, this issue needs adequate attention else it would lead to more such frauds.

Various studies on remuneration schemes of executives in Indian Companies have reflected majorly 3 issues:

The remuneration is not strictly based on performance. The highest paid executives are usually not from the best performing companies and many a times even when the value of shares is declining constantly there is no major effect on the remuneration of top executives.
There is a huge gap in the compensation level of executives and median employees. The supports for high remuneration state that this is due to the dearth of talent at the top level but even then such a glaring difference in the basic pay as well as in the % increase in pay as compared to median employees is not justified.
Also, the studies have found that the promoter CEOs are paid much more in comparison to Non promoter CEOs.

In this paper I would basically study the reasons behind the above findings and would majorly focus on efficiency of current regime in curbing the same and also the role of other interested entities which can serve as a control mechanism on executive remuneration.

For this purpose firstly, analyze the context of executive remuneration and the issues associated with it wherein will focus on agency problem and also the role of ownership structure in enhancing the problem. Then would annalyse the efficacy of checks provided by the current regime on Executive remuneration i.e. Shareholders say on pay, Remuneration committee and linking Remuneration to performance. Lastly, examine the role of Institutional investors as a control mechanism against executive remuneration.

Meaning of Remuneration

Remuneration has been described in section 2(78) of the Companies Act 2013.As per this definition any payment in the form of money or its equivalent would be counted as remuneration. Perquisites would also be included in determining total remuneration. Perquisites in this case are those as defined under the Income tax Act, 1961.

Remuneration can be paid in various forms like cash, medical benefits, retirement benefits, share options, shares, sitting fee and perks and allowances like contribution to provident fund, rent free accommodation, travelling expenses, car etc. It is usually a combination of various forms. Certain perquisites and compensations are explicitly exempted from being counted as a part of remuneration

Role of Executive Remuneration

The role of executive remuneration is to attract and retain top talent at executive position and incentivize them in the way that they work for the benefit of the company while furthering the objective of the company and increasing the value of the firm.

Interplay Between Fixed and Variable Component

The role of fixed component is to fulfill the immediate needs of the employees. All types of companies are open to certain sector specific risks and fixed component reduces the effect of this risk by assuring certain determined amount of income.

On the other hand, variable component can be used to align the interest of executives to the interest of company. For example, if the executives are provided with certain number of shares as a part of remuneration then better performance would lead to increase in the share value of the company and would also increase executive’s compensation.

If the executives receive just fixed remuneration with no variable component then instead of working as incentive, it would actually dilute its effect and if the compensation would include only variable component then this would also frustrate the employee.

Thus, there must be combination of fixed as well as variable component wherein the fixed component work as an incentive to work and the variable component makes sure that the work is done in the interest of the company. Also, it is necessary that there must be interaction between various forms of compensation and the remuneration scheme must be arranged in a way that it is incentive based.

Capital Gain (Section. 45, 48, 49, 50 and 54)

by indiafreenotes26/10/202018/10/20241

The income from capital gains is not an income which accrues or arises from day-to-day during a specific period but it arises at fixed point of time, namely, on the date of the transfer of a capital asset. Specifically, the income from capital gains is the amount by which the sale price of a capital asset, net of any expense incurred in connection with the sale of the asset, exceeds the acquisition cost of the capital asset. The taxation of capital gains is justified by the taxation policy and law on the premise that capital gains increases the ‘ability to pay’ capacity of the person receiving such a gain.

The provisions related to taxation of capital gains were first introduced in 1947 and then in 1956 and then said section 12B in Income tax Act, 1922 was retained as such in the relevant provisions in Income tax Act, 1961.

Charging sections – Sections 45, 46 and 46A

The charging section explains the subject matter of taxation. Thus, there is one charging section for each head of income for salaries, income from house property, business income and income from other sources. However, for capital gains, there are three independent and separate charging sections:

(i) Section 45: Capital gains

(ii) Section 46: Capital gains on distribution of assets by companies in liquidation

(iii) Section 46A: Capital gains on purchase by company of its own shares or other securities

Section 45 is the general provision while sections 46 and 46A are special provisions.

Incomes to be taxed under the head, ‘Capital Gains’

Thus, the following incomes are taxable as ‘capital gains’:

Sr. No.	Particulars	Section
(1)	Any profits and gains arising from the transfer of a capital asset effected in the previous year.	Section 45(1) to (5)
(2)	Any profits and gains arising from the receipt of any money or other assets under an insurance from an insurer on account of damage to, or destruction of, any capital asset, as a result of (i) flood, typhoon, hurricane, cyclone, earthquake or other convulsion of nature; or (ii) riot or civil disturbance; or (iii) accidental fire or explosion; or (iv) action taken by an enemy or in combating an enemy.	45(1A)
(3)	Capital gains in respect of any money or other assets received by shareholder of a company from the company on its liquidation	46(2)
(d)	Difference between (i) value of consideration received by shareholder or holder of specified securities from company on buyback of its own shares or other specified securities; and (ii) cost of acquisition	46A

The situs/location of capital asset matters only for non-resident assessees and not to others. In the cases of Non-resident assessees, if capital asset located outside India is transferred outside India and sale proceeds are received outside India, no taxability to capital gains arises in view of section 5 of the Act. Such assessees will be liable to be taxed under section 9(1) (i) in respect of capital gains accruing or arising “through the transfer of any capital asset situate in India”.

Important Definitions in capital gains

Sr. No.	Term	Definition	Exceptions and remarks
1	Capital Asset	A capital asset means property of any kind held by an assessee, whether or not connected with his business or profession Any securities held by an FII	Assets Listed: (a) jewellery; (b) archaeological collections; (c) drawings; (d) paintings; (e) sculptures; or (f) any work of art (g) Land other than agricultural land (h) Rights in a company
2			Exclusions: (i) any stock in trade (ii) movable assets for personal use (iii) agricultural land in India (iv) Gold bonds issued by GoI (v) Special bearer bonds (vi) Gold Deposit Bonds
2	Agricultural land	Land not situated within municipal jurisdiction or Cantt. Board and having population of more than 10000 Within 2 kms of municipal limits of jurisdiction with a population 10000>100000 and 6 kms for jurisdiction with population 100000>1000000 and 8kms for population >1000000	This amendment is applicable from A Y 2014-15 and the distance from municipal limits has to be measured aerially and not on the ground.
3	Transfer	Sale, exchange or relinquishment of the asset Extinguishment of rights in the asset Compulsory acquisition under the law Conversion of asset into stock in trade Maturity or redemption of a zero coupon bond Part performance of a contract Enjoyment of a property through acquisition of shares
	Indexed Cost of acquisition	an amount which bears to the cost of acquisition the same proportion as Cost Inflation Index for the year in which the asset is transferred bears to the Cost Inflation Index for the first year in which the asset was held by the assessee or for the year beginning on the 1st day of April, 1981, whichever is later;	From A Y 2018-19, the year 1981 shall be replaced by 2000
	Indexed Cost of any improvement	An amount which bears to the cost of improvement the same proportion as Cost Inflation Index for the year in which the asset is transferred bears to the Cost Inflation Index for the year in which the improvement to the asset took place
	Cost Inflation Index	Such Index as the Central Government may, having regard to seventy-five per cent of average rise in the (Consumer Price Index (urban)) for the immediately preceding previous year to such previous year, by notification in the Official Gazette, specify, in this behalf

Meaning of Transfer [Section 2(47)]

“Transfer”, in relation to a capital asset, includes:

(i) Sale, exchange or relinquishment of the asset;

(ii) Extinguishment of any rights in relation to a capital asset;

(iii) Compulsory acquisition of an asset;

(iv) Conversion of capital asset into stock-in-trade;

(v) Maturity or redemption of a zero coupon bond;

(vi) Allowing possession of immovable properties to the buyer in part performance of the contract;

(vii) Any transaction which has the effect of transferring an (or enabling the enjoyment of) immovable property; or

(viii) Disposing of or parting with an asset or any interest therein or creating any interest in any asset in any manner whatsoever.

Transactions which are not regarded as transfer [Section 47]

Following transactions shall not be regarded as transfer (subject to certain condition). Hence, following transaction shall not be charged to capital gains:

Section	Particulars
46(1)	Distribution of asset in kind by a company to its shareholders at the time of liquidation
47(i)	Distribution of capital asset on total or partial partition of HUF
47(iii)	Transfer of capital asset under a gift or will or an irrevocable trust
47(iv)	Transfer of capital asset by a company to its wholly owned subsidiary company
47(v)	Transfer of a capital asset by a wholly owned subsidiary company to its holding company
47(vi)	Transfer of capital assets in a scheme of amalgamation
47(via)	Transfer of shares in an Indian company held by a foreign company to another foreign company under a scheme of amalgamation of the two foreign companies
47(viab)	Transfer of share of a foreign company (which derives, directly or indirectly, its value substantially from the share or shares of an Indian company) held by a foreign company to another foreign company under a scheme of amalgamation (subject to conditions)
47(viaa)	Transfer of capital assets in a scheme of amalgamation of a banking company with a banking institution
47(vib)	Transfer of capital assets by the demerged company to the resulting company in a demerger
47(vic)	Transfer of shares held in an Indian company by a demerged foreign company to the resulting foreign company
47(vica)	Any transfer of a capital asset by the predecessor co-operative bank to the successor co-operative bank in a business reorganization.
47(vicb)	Any transfer of capital asset (being shares) held by a shareholder in the predecessor co-operative bank if the transfer is made in consideration of the allotment to him of any shares in the successor co-operative bank in a scheme of business reorganization
47(vicc)	Transfer of share of a foreign company (which derives, directly or indirectly, its value substantially from the share or shares of an Indian company) held by a demerged foreign company to resulting foreign company in case of demerger (subject to conditions)
47(vid)	Transfer or issue of shares by the resulting company to the shareholders of the demerged company in a scheme of demerger
47(vii)	Allotment of shares in amalgamated company in lieu of shares held in amalgamating company
47(viia)	Transfer of capital assets (being foreign currency convertible bonds or GDR) by a non-resident to another non-resident
47(viiaa)	Any transfer made outside India, of a capital asset (being rupee denominated bond of an Indian company issued outside India) by a non-resident to another non-resident
47(viiab)	Any transfer of following capital assets by a non-resident on a recognised stock exchange located in any International Financial Services Centre: a) Bond or GDR b) Rupee Denominated Bond of an Indian Co. c) Derivative d) Such other Securities as may be prescribed.
47(viib)	Transfer of capital assets (being a Government security carrying periodic payment of interest) outside India through an intermediary dealing in settlement of securities by a non-resident to another non- resident
47(viic)	Redemption of capital asset being sovereign gold bond issued by RBI under the Sovereign Gold Bond Scheme, 2015
47(ix)	Transfer of a capital asset (being work of art, manuscript, painting, etc.) to Government, University, National museum, etc.
47(x)	Transfer by way of conversion of bonds or debentures into shares
47(xa)	Transfer by way of conversion of bonds [as referred to in section 115AC(1)(a)] into shares or debentures of any company
47(xb)	Any transfer by way of conversion of preference shares into equity shares
47(xi)	Transfer by way of exchange of a capital asset being membership of a recognized stock exchange for shares of a company
47(xii)	Transfer of land by a sick industrial company which is managed by its workers’ co-operative
47(xiii)	Transfer of a capital asset by a firm to a company in the case of conversion of firm into company
47(xiiia)	Transfer of a capital asset being a membership right held by a member of a recognized stock exchange in India
47(xiiib)	Transfer of a capital asset by a private company or unlisted public company to an LLP, or any transfer of shares held in the company by a shareholder, in the case of conversion of company into LLP
47(xiv)	Transfer of a capital asset to a company in the case of conversion of proprietary concern into a company
47(xv)	Transfer involved in a scheme of lending of securities
47(xvi)	Transfer of a capital asset in a transaction of reverse mortgage made under a scheme notified by the Government
47(xvii)	Transfer of a capital asset (being share of a special purpose vehicle) to a business trust in exchange of units allotted by that trust to the transferor
47(xviii)	Transfer of units of a mutual fund pursuant to consolidation of two or more schemes of equity oriented mutual fund or of two or more schemes of a mutual fund other than equity oriented mutual fund
47(xix)	Transfer of units of a mutual fund from one plan to another pursuant to consolidation of plans within scheme of mutual funds.

Full Value of Consideration

Full value of consideration is the consideration received or receivable by the transferor in lieu of assets, which he has transferred. Such consideration may be received in cash or in kind. If it is received in kind, then fair market value (‘FMV’) of such assets shall be taken as full value of consideration.

However, in the following cases “full value of the consideration” shall be determined on notional basis as per the relevant provisions of the Income-tax Act, 1961:

S. No.	Nature of transaction	Section	Full Value of Consideration
1.	Money or other asset received under any insurance from an insurer due to damage or destruction of a capital asset	45(1A)	Value of money or the FMV of the asset (on the date of receipt)
2.	Conversion of capital asset into stock-in-trade	45(2)	FMV of the capital asset on the date of conversion
3.	Transfer of capital asset by a partner or member to firm or AOP/BOI, as the case may be, as his capital contribution	45(3)	Amount recorded in the books of accounts of the firm or AOP/BOI as the value of the capital asset received as capital contribution
4.	Distribution of capital asset by Firm or AOP/BOI to its partners or members, as the case may be, on its dissolution	45(4)	FMV of such asset on the date of transfer
5.	Money or other assets received by share- holders at the time of liquidation of the company	46(2)	Total money plus FMV of assets received on the date of distribution less amount assessed as deemed dividend under section 2(22)(c)
6.	Buy-back of shares and other specified securities by a company	46A	Consideration paid by company on buyback of shares or other securities would be deemed as full value of consideration. The difference between the cost of acquisition and buy-back price (full value of consideration) would be taxed as capital gain in the hands of the shareholder. However, in case of buy-back of shares by a domestic company (whether listed* or unlisted), the company shall be liable to pay additional tax at the rate of 20% under section 115QA on the distributed income (i.e., buy-back price as reduced by the amount received by the company for issue of such shares). Consequently, capital gain arising in hands of shareholder shall be exempt by virtue of section 10(34A) in such cases. *With effect from 05/07/2019, section 115QA has been amended to levy additional tax on buy back of shares by listed companies as well. Consequently, section 10(34A) has also been amended to exempt income arising in hands of shareholder on account of buy back of shares by listed companies. x
7.	Shares, debentures, warrants (‘securities’) allotted by an employer to an employee under notified Employees Stock Option Scheme and such securities are gifted by the concerned employee to any person	Fourth Proviso to Section 48	Fair Market value of securities at the time of gift
7A.	Conversion of capital asset into stock-in-trade	49	FMV of the inventory as on the date of conversion
8.	In case of transfer of land or building, if sale consideration declared in the conveyance deed is less than the stamp duty value	50C	The value adopted or assessed or assessable by the Stamp Valuation Authority shall be deemed to be the full value of consideration. However, no such adjustment is required to be made if value adopted for stamp duty purposes does not exceed 110% of the sale consideration. Note: Where the date of agreement (fixing the amount of consideration) and the date of registration for the transfer of property are not the same, the value adopted or assessed or assessable by Stamp Valuation Authority on the date of agreement may be taken as full value of consideration.
8A.	Where consideration for transfer of unquoted shares is less than the Fair Market Value	50CA	The Fair Market Value (so determined in prescribed manner) shall be deemed to be the full value of consideration Note: The Board may prescribe transactions undertaken by certain class of persons to which the provisions of Section 50CA shall not be applicable. (w.e.f. Assessment Year 2020-21)
9.	If consideration received or accruing as a result of transfer of a capital asset is not ascertainable or cannot be determined	50D	FMV of asset on the date of transfer

Cost of Acquisition

Cost of acquisition of an asset is the amount for which it was originally acquired by the assessee. It includes expenses of capital nature incurred in connection with such purchase or for completing the title of the property.

However, in cases given below, cost of acquisition shall be computed on notional basis:

S. No.	Particulars	Notional Cost of Acquisition
1.	Additional compensation in the case of compulsory acquisition of capital assets	Nil
2.	Assets received by a shareholder on liquidation of the company	FMV of such asset on the date of distribution of assets to the shareholders
3.	Stock or shares becomes property of taxpayer on consolidation, conversion, etc.	Cost of acquisition of such stock or shares from which such asset is derived
4.	Allotment of shares in an amalgamated Indian co. to the shareholders of amalgamating co. in a scheme of amalgamation	Cost of acquisition of shares in the amalgamating co.
5.	Conversion of debentures into shares	That part of the cost of debentures in relation to which such asset is acquired by the assessee
5A.	Conversion of preference shares into equity shares	The part of the cost of preference shares in relation to which such asset is acquired by the assessee.
6.	Allotment of shares/securities by a co. to its employees under ESOP Scheme approved by the Central Government	a) If shares are allotted during 1999-2000 or on or after April 1, 2009, FMV of securities on the date of exercise of option b) If shares are allotted before April 1, 2007 (not being during 1999-2000), the amount actually paid to acquire the securities c) If shares are allotted on or after April 1, 2007 but before April 1, 2009, FMV of securities on the date of vesting of option (purchase price paid to the employer or FBT paid to employer shall not be considered)
6A.	Listed Equity Shares or Units of Equity Oriented Funds or Units of Business Trust as referred to in Section 112A acquired before February 1, 2018.	Higher of : (i) Cost of acquisition of such asset; and (ii) Lower of: (A) The fair market value of such asset; and (B) The full value of consideration received or accruing as a result of transfer of such asset. Note: For meaning of ‘Fair market Value’ refer Explanation to Section 55(2)(ac).
7.	Property covered by section 56(2)(vii) or (viia) or (x)	The value which has been considered for the purpose of Section 56(2)(vii) or (viia) or (x)
8.	Allotment of shares in Indian resulting company to the existing shareholders of the demerger company in a scheme of demerger	Cost of acquisition of shares in demerged company ? Net book value of assets transferred in demerger ? Net worth of the demerged company immediately before demerger
9.	Cost of acquisition of original shares in demerged company after demerger	Cost of acquisition of such shares minus amount calculated above in point 8.
10.	Cost of acquisition of assets acquired by successor LLP from predecessor private company or unlisted public company at the time of conversion of the company into LLP in compliance with conditions of Section 47(xiiib)	Cost of acquisition of the assets to the predecessor private company or unlisted public company
11.	Cost of acquisition of rights of a partner in a LLP which became the property of the taxpayer due to conversion of a private company or unlisted public company into the LLP	Cost of acquisition of the shares in the co. immediately before conversion
12.	Depreciable assets covered under Section 50	Opening WDV of block of assets on the first day of the previous year plus actual cost of assets acquired during the year which fall within the same block of assets
13.	Depreciable assets of a power generating unit as covered under Section 50A*	WDV of the asset minus terminal depreciation plus balancing charge
14.	Undertaking/division acquired by way of slump sale as covered under Section 50B	Net worth of such undertaking
15.	New asset acquired for claiming exemptions under sections 54, 54B, 54D, 54G or 54GA if it is transferred within three years	Actual cost of acquisition minus exemption claimed under these sections
16.	Goodwill of business or trade mark or brand name associated with business or right to manufacture, produce or process any article or thing or right to carry on any business or profession, tenancy right, stage permits or loom hours	a) If these assets were acquired by gift, will, etc., under section 49(1) and the previous owner had purchased these assets: Cost of acquisition to the previous owner b) If the owner has purchased these assets: Actual cost of acquisition c) If these assets are self-generated: Nil
17.	Right shares	Amount actually paid by assessee
18.	Right to subscribe to shares (i.e., right entitlement)	Nil
19.	Bonus shares	a) If allotted to the assessee before April 1, 1981: Fair market value on that date b) In any other case: Nil
20.	Allotment of equity shares and right to trade in stock exchange, allotted to members of stock exchange under a scheme of demutualization or corporatization of stock exchanges as approved by SEBI	a) Cost of acquisition of shares: Cost of acquisition of original membership of the stock exchange b) Cost of acquisition of trading or clearing rights of the stock exchange: Nil
21.	Capital asset, being a unit of business trust, acquired in consideration of transfer as referred to in section 47(xvii)	Cost of acquisition of shares as referred to in section 47(xvii) [applicable from AY 2015-16]
	Units allotted to an assessee pursuant to consolidation of two or more scheme of a mutual fund as referred to in Section 47(xviii)	Cost of acquisition of such units shall be the cost of acquisition of units in the consolidating scheme of the mutual fund
	Shares in a company acquired by the non-resident assessee on redemption of Global Depository Receipts referred to in Section 115AC(1)(b)	Cost of acquisition of such shares shall be calculated on the basis of the price prevailing on any recognized stock exchange on the date on which a request for such redemption was made.
24.	Any other capital asset:	a) If it became property of taxpayer before April 1, 2001 by gift, will, etc., in modes specified in section 49(1): Cost of acquisition to the previous owner or FMV as on April 1, 2001, whichever is higher. Note: The FMV on 1st April, 2001 shall not exceed the stamp duty value of such asset as on 1st April, 2001 where such stamp duty value is available. (this amendment will be applicable w.e.f. AY 2021-22) b) If it became property of taxpayer before April 1, 2001 : Cost of acquisition or FMV as on April 1, 2001, whichever is more Note: The FMV on 1st April, 2001 shall not exceed the stamp duty value of such asset as on 1st April, 2001 where such stamp duty value is available. (this amendment will be applicable w.e.f. AY 2021-22) c) If it became property of taxpayer after April 1, 2001 by gift, will, etc., in modes specified in section 49(1): Cost of acquisition to the previous owner d) If it became property of taxpayer after April 1, 2001 : Actual cost of acquisition

* Terminal Depreciation/Balancing Charge:

a) Balancing Charge = Sales Consideration – WDV of the depreciable asset
b) Terminal Depreciation = WDV – Sales Consideration

Commodities Market, Meaning, History and Origin, Features, Classification

by indiafreenotes02/10/202010/04/20251

Commodities market in India refers to the trading of raw materials and primary agricultural products like gold, silver, crude oil, metals, and agricultural commodities. It plays a crucial role in price discovery, risk management, and ensuring liquidity. The Multi Commodity Exchange (MCX) and National Commodity and Derivatives Exchange (NCDEX) are the two major exchanges facilitating commodities trading in India. These markets allow hedging against price fluctuations and provide opportunities for investors to diversify their portfolios. The commodity derivatives market includes futures and options contracts, which help participants manage risks related to price volatility. The commodities market contributes to India’s economic development by improving market efficiency and supporting both producers and consumers.

History and Origin of Commodities Market:

The origin of the commodities market can be traced back to ancient civilizations, where the exchange of goods, primarily agricultural products, and raw materials was a fundamental part of trade. The commodities market, as we know it today, has evolved significantly over centuries, driven by the need for structured trading, price discovery, and risk management.

Ancient Civilizations and Early Trading

The concept of commodities trading can be traced back to Mesopotamia around 3000 BCE, where grain was traded. The ancient Sumerians used clay tablets to record transactions, which are considered the earliest forms of futures contracts. These early forms of trade were often linked to agricultural products such as grains, livestock, and metals. In Egypt and Greece, similar trade practices evolved, with local markets developing around major cities to facilitate the exchange of agricultural goods and resources.

Emergence of Futures Contracts

The formalization of futures contracts began in Japan in the 17th century. The Dojima Rice Exchange was established in 1697 in Osaka, Japan, marking the world’s first futures market. Farmers and merchants used this exchange to enter into contracts that allowed them to lock in future prices for rice. This practice was crucial for both producers, who wanted to secure income, and merchants, who sought to ensure consistent supply. The Dojima Exchange set the foundation for futures trading, which is now a cornerstone of modern commodities markets.

Commodities Market in the United States

In the United States, the history of commodities markets began in the early 19th century. The Chicago Board of Trade (CBOT) was established in 1848, and it became one of the most influential commodity exchanges globally. Initially, the exchange focused on agricultural products such as corn, wheat, and oats, vital to the U.S. economy at the time. The CBOT introduced standardized contracts for the trading of these commodities, which helped promote transparency, liquidity, and price discovery.

The futures contracts introduced by the CBOT allowed producers to hedge against price fluctuations, providing a financial safety net. Over time, this concept expanded to include a broader range of commodities, including energy products like oil and natural gas, as well as precious metals such as gold and silver.

Evolution of the Modern Commodities Market

The growth of the global economy and advances in technology contributed significantly to the expansion of commodities markets. The creation of electronic trading platforms and online exchanges allowed for quicker execution of trades and greater market participation. In India, the modern commodities market began to take shape in the late 20th century.

National Commodity and Derivatives Exchange (NCDEX) and Multi Commodity Exchange (MCX) were established in India in 2003 and 2004, respectively, to provide structured platforms for trading a variety of commodities, including metals, energy, and agricultural goods. These exchanges were designed to help manage price risks, ensure liquidity, and contribute to the overall development of India’s commodity market.

Features of Commodities Market:

Variety of Commodities:

The commodities market in India deals with a wide range of raw materials and primary products. These include agricultural commodities like wheat, rice, and cotton, and non-agricultural commodities such as gold, silver, crude oil, and industrial metals like copper, aluminum, and steel. The diversity of commodities allows traders and investors to participate in various sectors and manage their exposure to different risks.

Physical and Derivatives Market:

The commodities market consists of two segments: the physical market and the derivatives market. The physical market involves the direct buying and selling of the commodities, while the derivatives market includes contracts such as futures and options, which allow traders to hedge against price fluctuations. The derivatives market enables participants to lock in prices for future delivery, thus offering protection against price volatility.

Price Discovery and Transparency:

One of the main functions of the commodities market is price discovery. Through active trading and supply-demand dynamics, the market establishes transparent and fair prices for commodities. The prices in the market reflect real-time economic conditions, geopolitical factors, and other relevant influences, providing both producers and consumers with valuable insights into market trends and price movements.

Hedging Opportunities:

Commodities markets offer participants a chance to hedge against price volatility and uncertainties. For instance, producers like farmers or mining companies can use futures contracts to lock in a specific price for their products, protecting themselves from adverse price movements. Similarly, importers and exporters can hedge against exchange rate fluctuations or price changes in global markets.

Regulation and Oversight:

The commodities market in India is regulated by organizations like the Securities and Exchange Board of India (SEBI) and the Forward Markets Commission (FMC). These regulatory bodies ensure that the market operates with transparency, fairness, and integrity, protecting the interests of all participants. Exchanges such as MCX and NCDEX play a central role in maintaining order and enforcing rules for smooth market operations.

Liquidity:

The commodities market provides liquidity, enabling traders to buy or sell commodities quickly and efficiently. Liquidity is essential for price discovery and helps investors enter or exit positions without significant price distortion. With high liquidity, participants are assured that they can execute their trades at prevailing market prices, making the market more attractive for both institutional and retail investors.

Classification of Commodities Market:

Physical (Spot) Market

The physical or spot market is where commodities are bought and sold for immediate delivery and payment. Transactions occur on the spot, meaning buyers pay and take possession of the goods right away. This market deals with tangible commodities such as agricultural produce, metals, and energy products. Prices are determined based on current supply and demand conditions. Spot markets are typically used by manufacturers, traders, and consumers who need physical delivery of goods. These markets operate through auction systems, trading floors, or over-the-counter (OTC) channels, and they form the foundation for futures and derivatives pricing.

Futures Market

The futures market involves contracts to buy or sell commodities at a future date at a predetermined price. It allows buyers and sellers to hedge against price fluctuations by locking in prices in advance. No physical exchange of goods occurs at the time of the agreement. This market is essential for risk management, price discovery, and speculation. Standardized contracts are traded on exchanges like MCX or NCDEX. The futures market is regulated to ensure transparency, and it attracts investors, producers, exporters, and large buyers looking to mitigate risks related to price volatility in commodity markets.

Over-the-Counter (OTC) Market

The OTC commodities market allows for direct trading between two parties without exchange involvement. These contracts are customized in terms of volume, delivery date, and settlement terms, catering to specific needs of large players like corporates or institutional buyers. Since OTC markets are not standardized, they offer flexibility, but also carry higher counterparty risk. Commonly traded OTC commodities include crude oil, metals, and grains. Though not as regulated as exchange-traded markets, OTC trading plays a significant role in global commodities pricing and is often used for complex financial strategies or hedging requirements.

Exchange-Traded Market

This market refers to commodity transactions that occur through regulated exchanges such as MCX (Multi Commodity Exchange) or NCDEX (National Commodity & Derivatives Exchange) in India. These markets offer transparency, standardization, and reduced counterparty risk due to regulatory oversight. Commodities are traded in standardized contract sizes and delivery specifications. Prices are determined through market dynamics and published in real-time. Traders, investors, and hedgers participate actively in this platform, making it a key part of the financial system. Exchange-traded commodity markets promote efficient price discovery, liquidity, and facilitate fair and transparent commodity trading.

Stock Market Index, Types, Purpose, Methodology, Advantages

by indiafreenotes05/09/202009/01/20251

An index is a statistical measure that represents the performance of a group of assets, securities, or economic indicators. It aggregates the performance of a set of selected items and provides a benchmark against which individual assets or sectors can be compared. In financial markets, indices are crucial tools for assessing the overall market health, measuring the return on investments, and guiding portfolio management decisions.

Types of Index:

Stock Market Index

Stock market index is a collection of stocks from different sectors that reflects the overall performance of a stock market. It is designed to represent a segment of the market or the entire market. For example, the S&P 500 includes 500 large-cap companies in the U.S., while the Nifty 50 consists of 50 companies listed on the National Stock Exchange (NSE) in India. These indices provide a snapshot of the market’s direction and are used as performance benchmarks.

Economic Index

An economic index tracks various economic indicators, such as inflation, employment rates, and consumer confidence, to gauge the health of an economy. Examples include the Consumer Price Index (CPI), which measures inflation, and the Index of Industrial Production (IIP), which measures industrial output in an economy. These indices help policymakers, businesses, and investors assess the state of the economy and make informed decisions.

Bond Market Index

Bond market index tracks the performance of fixed-income securities, such as government bonds, corporate bonds, or municipal bonds. The Bloomberg Barclays Global Aggregate Bond Index is a prominent example. It is used to track changes in the value of a bond portfolio, providing investors with insights into interest rate changes, credit risk, and other factors affecting the bond market.

Commodity Index

Commodity index tracks the prices of a basket of commodities, such as oil, gold, agricultural products, and metals. Examples of commodity indices include the S&P GSCI (formerly the Goldman Sachs Commodity Index). These indices serve as benchmarks for the performance of commodities and are used by traders, investors, and businesses to hedge against risks related to commodity price fluctuations.

Sectoral Index

Sectoral index represents a specific industry or sector within the broader market. For example, the Nifty Bank Index tracks the performance of banks listed on the NSE, while the BSE IT Index tracks IT companies. These indices are used by investors looking to gain exposure to specific sectors, as well as to gauge sector performance.

Volatility Index

Volatility index, such as the VIX, measures market expectations of future volatility. It is also known as the “fear gauge” because it often rises during periods of market uncertainty and economic downturns. The VIX tracks the implied volatility of options on the S&P 500 index and is often used by investors to gauge market sentiment and make trading decisions.

Purpose of an Index:

Benchmarking

Indices serve as a benchmark for evaluating the performance of individual stocks, mutual funds, or investment portfolios. For instance, a fund manager might compare the performance of a portfolio to the S&P 500 to see whether it has outperformed or underperformed the market.

Market Indicator

An index provides a quick and broad indication of market trends, helping investors assess whether the market is in a bullish (rising) or bearish (falling) phase. A rising index generally signals a growing economy, while a falling index suggests economic contraction.

Investment Decision-Making

Indices guide investment decisions by helping investors track the performance of various sectors or asset classes. Index-based investing, such as through exchange-traded funds (ETFs), allows investors to gain exposure to broad market movements or specific sectors without buying individual stocks or securities.

Risk Management

Indices help investors diversify their portfolios and manage risk by representing a basket of assets. For example, by investing in an index that tracks the performance of a diverse group of stocks, an investor can reduce the risk associated with investing in any single company or asset class.

Passive Investing

Passive investment strategies often involve investing in index funds or exchange-traded funds (ETFs) that track the performance of a market index. These strategies aim to replicate the performance of the index, typically resulting in lower fees and a more hands-off approach compared to actively managed funds.

Methodology of Index Construction

Selection of Components

The selection of stocks or assets that make up an index is a critical aspect of its construction. For example, in a price-weighted index (like the Dow Jones Industrial Average), the component with the highest stock price has the most significant impact on the index’s value. In contrast, in a market-capitalization-weighted index (like the S&P 500), larger companies with higher market value have a greater influence on the index.

Calculation

Indices are calculated using specific formulas, which vary depending on the type of index. Generally, the index value is calculated by taking the sum of the prices or values of all the components, adjusted for stock splits, dividends, or other corporate actions. For example, a market-capitalization-weighted index is calculated by multiplying the stock prices by their respective market capitalizations and then summing the results.

Rebalancing

Most indices are periodically rebalanced to ensure that they accurately reflect the current market environment. This may involve adding or removing stocks from the index based on changes in market capitalization, sector performance, or other factors.

Advantages of Using an Index

Transparency

Indices provide a transparent view of the market or sector, as their composition and calculation method are typically published and widely available.

Diversification

By investing in an index, investors gain exposure to a diversified portfolio of assets, reducing the risk associated with individual investments.

Cost-Effective

Index-based funds and ETFs are generally more cost-effective than actively managed funds because they involve lower management fees and transaction costs.

Performance Measurement

Indices offer a straightforward way to measure the performance of a portfolio or asset class, enabling investors to assess the success of their investments relative to the market.

Central Securities Depository Ltd. (CSDL), Functions, Benefits

by indiafreenotes23/08/202009/01/20253

Central Securities Depository Ltd. (CSDL) is a significant entity in the Indian financial market, playing a pivotal role in the dematerialization of securities and enhancing the efficiency of the securities settlement process. It is responsible for managing the holding and settlement of securities in electronic form, a service that has revolutionized the Indian securities market by facilitating paperless transactions, reducing risks, and promoting transparency.

CSDL was established in 1999 and is one of the two depositories operating in India, the other being the National Securities Depository Limited (NSDL). Both CSDL and NSDL are regulated by the Securities and Exchange Board of India (SEBI), which ensures their compliance with industry standards and governance practices.

Functions of CSDL:

Dematerialization of Securities:

CSDL’s primary function is to convert physical securities, such as shares, bonds, and debentures, into electronic form. This process is called dematerialization, and it has significantly reduced the risks associated with physical securities, including theft, forgery, and loss. Investors can hold securities in their demat accounts, and transactions are executed electronically.

Settlement of Securities:

CSDL plays a vital role in the settlement of securities transactions in the stock markets. It facilitates the efficient transfer of securities between buyers and sellers by ensuring that securities are transferred electronically upon payment, ensuring seamless and secure transactions.

Centralized Custody:

CSDL provides centralized custody of securities, allowing investors to hold their securities in a safe and accessible electronic format. By acting as a custodian, it minimizes the risks of holding securities physically and offers a more transparent, secure, and efficient system.

Investor Services:

CSDL offers various services to investors, such as corporate actions (like dividend payments, stock splits, bonus issues, etc.), electronic transfer of securities, and nomination facilities for demat accounts. It also provides an electronic platform for investors to access their holdings, monitor transactions, and update account details.

Pledge and Lien Services:

CSDL offers a pledge and lien facility that enables investors to pledge their securities for borrowing purposes. This facility is essential for leveraging securities as collateral in various financial transactions, such as margin funding or loans.

Electronic Book Entry System:

CSDL’s electronic book entry system ensures that securities transactions are recorded electronically, ensuring that investors’ holdings are updated and accessible instantly. This system eliminates paperwork, reduces human errors, and accelerates the settlement process.

Systematic Investment Plan (SIP):

CSDL has enabled Systematic Investment Plans (SIPs) through mutual fund units. Investors can automatically invest in mutual fund schemes through their demat accounts, which are electronically recorded and tracked by CSDL.

Benefits of CSDL

Efficiency and Speed:

By converting physical securities into electronic form, CSDL ensures that securities transactions are processed quickly, reducing the time and effort required for manual paperwork. The settlement time is also significantly reduced, contributing to quicker transfer of securities and funds.

Reduced Risk:

CSDL reduces the risks associated with holding physical securities. The chances of theft, damage, or loss of securities are eliminated since all transactions are executed electronically. Additionally, it reduces counterparty risks and the potential for fraud in securities transfers.

Cost-Effectiveness:

The dematerialization process eliminates the need for printing and handling physical certificates, leading to reduced administrative and processing costs. Investors also save on expenses like stamp duty and courier charges for physical certificates.

Transparency and Security:

The electronic system operated by CSDL ensures greater transparency in the securities market. All transactions are recorded in real-time, making it easier to track ownership and transfer of securities. This system enhances investor confidence and reduces the potential for manipulation.

Accessibility:

CSDL provides easy access to securities for investors. They can hold and trade their securities in a convenient manner through their demat accounts. The platform is accessible 24/7, providing a reliable and efficient interface for securities management.

Corporate Actions:

CSDL ensures that all corporate actions (such as dividends, bonus issues, stock splits, etc.) are automatically credited to the respective demat accounts of investors. This removes the need for manual intervention and ensures that investors receive their entitlements promptly.

Global Access:

CSDL’s services are not limited to Indian investors. It also enables foreign investors to hold Indian securities in demat form, facilitating foreign investment in Indian markets and promoting capital inflows into the country.

Regulatory and Compliance Role:

CSDL is regulated by SEBI, which monitors and ensures that the depository’s operations are in line with Indian securities regulations. This regulatory oversight provides an added layer of trust for investors and ensures that CSDL follows best practices in terms of governance, security, and operational standards. It is also required to comply with International Financial Reporting Standards (IFRS), Anti-Money Laundering (AML) laws, and other industry norms.

National Securities Depository Ltd. (NSDL), Functions, Features, Benefits

by indiafreenotes23/08/202009/08/20252

National Securities Depository Ltd. (NSDL) is one of the two central depositories in India, playing a crucial role in the modernization and electronic settlement of securities. NSDL was established in 1996 with the objective of facilitating dematerialization of securities, enhancing the speed and transparency of the Indian financial markets, and providing a secure and efficient infrastructure for securities transactions. It operates under the regulatory framework of Securities and Exchange Board of India (SEBI) and has made significant contributions to the development of India’s capital markets.

Functions of NSDL:

Dematerialization of Securities:

The most vital function of NSDL is to convert physical securities (such as shares, bonds, and debentures) into electronic format. This process, known as dematerialization, eliminates the need for paper certificates and reduces risks such as loss, theft, or forgery. Investors hold securities in the form of electronic records in their demat accounts, which are maintained by NSDL.

Settlement of Securities:

NSDL plays a vital role in the settlement process by ensuring that securities transactions, whether buy or sell, are completed seamlessly. The transfer of securities and payment settlement is carried out electronically, facilitating faster and more secure transactions compared to the older physical transfer systems.

Centralized Custody of Securities:

As a central depository, NSDL offers custody services for dematerialized securities. By maintaining electronic records of securities, it ensures that investors can safely store their holdings, monitor their portfolio, and track any changes in ownership or entitlement without the risks associated with physical certificates.

Corporate Actions:

NSDL ensures that corporate actions, such as dividends, interest payments, stock splits, bonus issues, and rights offerings, are seamlessly executed and credited to the investor’s demat account. This reduces paperwork and delays for investors while ensuring that entitlements are accurately credited.

Electronic Book Entry System:

NSDL employs an electronic book entry system to record securities transactions. This system makes it possible for securities to be transferred between buyers and sellers electronically, without the need for physical documents. It provides real-time tracking and updates of transactions.

Pledge and Loan Facility:

NSDL also offers pledge and lien facilities, allowing investors to pledge their securities as collateral for loans. This facility is essential for investors who wish to leverage their holdings to meet financial needs while maintaining ownership of the securities.

Investor Services:

NSDL offers a range of services for investors, including the ability to track their securities holdings, update personal information, and access historical transaction records. It provides online platforms that make it easy for investors to manage their demat accounts.

Features of NSDL:

Paperless and Efficient:

NSDL’s transition to a paperless system has significantly reduced the administrative burden on investors, brokers, and financial institutions. Electronic processing is faster, more accurate, and more efficient than manual paperwork. The dematerialization of securities has eliminated issues like lost or stolen certificates, making the market more transparent and secure.

Wider Reach:

NSDL services not only cater to domestic investors but also facilitate foreign investment in Indian securities. International investors can hold and trade Indian securities in a demat format through NSDL, which helps attract foreign capital into the Indian economy.

Enhanced Security:

The electronic system provides better security than physical securities. With encryption and other security features, NSDL ensures that investor data and securities are protected from fraud, manipulation, or unauthorized access.

Accessibility:

Investors can access their accounts, conduct transactions, and perform other account-related activities from anywhere in the world. This makes the system convenient and accessible for investors both in India and abroad.

Cost Reduction:

By eliminating paper certificates and reducing manual intervention, NSDL has helped in lowering the costs associated with securities issuance, trading, and settlement. This reduction in costs has benefitted both investors and institutions involved in the securities market.

Real-Time Updates:

NSDL provides real-time updates for all securities transactions, making it easy for investors to track their portfolio performance and manage their holdings effectively.

Benefits of NSDL:

Faster and Efficient Transactions:

NSDL has reduced the time required for the settlement of securities transactions, bringing down the settlement cycle from several days (T+3) to a more efficient model. This speed is essential for the smooth functioning of the capital markets.

Investor Confidence:

The transparency and security offered by NSDL have helped build investor confidence in the Indian securities market. Investors can rely on the integrity and efficiency of the system, knowing that their securities are safely stored and securely traded.

Reduced Risk:

By eliminating the risks associated with physical certificates, such as theft, loss, or damage, NSDL has helped mitigate security risks in the market. The electronic system also minimizes errors during securities transactions.

Convenient Record-Keeping:

The electronic format allows for efficient record-keeping, tracking, and monitoring of securities. This is beneficial for investors, as it helps them easily view their holdings and transactions.

Reduced Operational Costs:

With electronic systems in place, NSDL has helped reduce operational costs for investors, brokers, and institutions involved in the capital markets.

Regulatory Oversight

NSDL operates under the supervision of SEBI, which is responsible for overseeing its compliance with market regulations. NSDL follows the guidelines set by SEBI and other regulatory bodies to ensure that it adheres to the best practices in securities depository operations. It also complies with various international standards in electronic securities settlement.

Provisions of Ind AS-7 (old AS 3)

by indiafreenotes27/07/202018/10/20242

Foreign currency cash flows:

Record cash flows (those cash flows which arise from transactions in foreign currency) in functional currency.
Cash flows of a foreign subsidiary shall be translated at the exchange rates between functional currency and foreign currency.
Exchange rate at the date of cash flows shall be applied. Ind AS 21 permits the use of exchange rate that approximates the actual rate.
Unrealized gains and losses arising from changes in foreign currency exchange rates are not cash flows. However, the effect of exchange rate changes on cash and cash equivalents is reported in the statement of cash flows in order to reconcile cash and cash equivalents at the beginning and the end of the period. This amount is presented separately from cash flows from operating, investing and financing activities.

Change in ownership (no such concept under AS 3):

Cash flows from obtaining / losing control in businesses (including subsidiary) shall be presented separately and classified as Investing activity and disclose the following:

Total amount of consideration
Portion of consideration consisting of cash and cash equivalents
Amount of cash and cash equivalent over which control is obtained / lost
Assets and liabilities (other than cash and cash equivalent) over which control is obtained / lost summarised in each major category.

2. Cash flow effects of losing control are not deducted from those of obtaining control.
3. Cash paid / received as consideration is reported net of cash and cash equivalents acquired / disposed on account of such transaction.
4. Cash flows arising from changes in ownership in subsidiary that do not result in a loss of control shall be classified as cash flows from financing activities, unless subsidiary is held by investment entity.

Non-cash Transactions:

Many investing and financing activities do not impact cash flows although they do affect the capital and asset structure of an entity. These shall be excluded from the statement of cash flows. Examples:

Acquisition of assets by means of a finance lease;
Conversion of debt to equity.
Issue of bonus shares
Conversion of term loan into equity shares

Such transactions shall be disclosed in the financial statements indicating investing / financing activity.

Changes in liabilities arising from financing activities (It was an amendment in Ind AS 7 and this provision was not there in AS 3):
• An entity shall provide the following disclosures to evaluate changes in liabilities arising from financing activities including both changes arising from cash flows and non-cash changes:
o changes from financing cash flows
o changes arising from obtaining or losing control of subsidiaries or other businesses;
o the effect of changes in foreign exchange rates;
o changes in fair values; and
o other changes.
• It also applies to changes in financial assets (for example, assets that hedge liabilities arising from financing activities) if cash flows from those financial assets included in cash flows from financing activities.
• Disclosure requirement can be fulfilled by: Reconciliation between the opening and closing balances in the balance sheet for liabilities arising from financing activities.
• If an entity discloses the same with disclosures of changes in other assets and liabilities, it shall disclose financing activities separately.
Disclosures:
• Components of cash and cash equivalents and reconciliation with amount appearing in balance sheet
• Policy adopted in determining composition of cash and cash equivalents
• Significant cash and cash equivalent that are not available for use by the entity (with commentary by management).
Examples: balance in unpaid dividend account, bank balance subject to legal restrictions, earmarked balances, bank balance for share application money / pending allotment of shares.
• Additional information (optional but standard encouraged the following disclosure):
o amount of undrawn borrowing facilities (indicating any restrictions on use)
o cash flows representing increases in operating capacity separately from cash flows required to maintain operating capacity;
o cash flows from operating, investing and financing activities of each reportable segment (same is required by Ind AS 108).

Demat System, Features, Process, Advantages and Disadvantages

by indiafreenotes21/07/202019/10/20242

Demat System (short for Dematerialization system) refers to the process of converting physical share certificates into electronic form, enabling investors to hold and trade shares digitally through a dematerialized account. Introduced in India in 1996, the dematerialization process revolutionized the stock market by eliminating the need for physical certificates, streamlining the trading process, and making securities transactions safer, faster, and more efficient. The demat system is managed by depositories such as the National Securities Depository Limited (NSDL) and Central Depository Services Limited (CDSL), which function under the regulation of the Securities and Exchange Board of India (SEBI).

Key Features of the Demat System

Electronic Form of Securities:

In the demat system, shares, bonds, debentures, and other securities are held in electronic form, eliminating the need for physical certificates. This offers ease of access and ensures that investors can quickly buy, sell, and transfer securities.

Demat Account:

Similar to a bank account for money, a demat account is an electronic account where securities are stored. Each investor must open a demat account with a Depository Participant (DP), such as a bank, brokerage firm, or financial institution. The DP acts as an intermediary between the investor and the depository (NSDL or CDSL).

Speed and Efficiency:

Dematerialization process allows for faster trading and settlement of securities. Before dematerialization, the physical transfer of shares took weeks or even months, involving paperwork and delays. Now, transactions are completed in a few days, with real-time updates.

Safety and Security:

Holding securities in dematerialized form reduces the risk of theft, loss, forgery, and damage associated with physical certificates. The electronic form ensures greater transparency, and investors can track their holdings online through their demat account.

No Stamp Duty:

No stamp duty is charged on the transfer of dematerialized securities, reducing transaction costs for investors.

Nomination Facility:

Investors can assign a nominee to their demat account, ensuring that in the event of the account holder’s death, the securities are smoothly transferred to the designated individual.

Multiple Securities in One Account:

In a demat account, an investor can hold various types of securities, such as shares, bonds, mutual funds, and government securities, in a single account, which offers greater convenience.

Process of Dematerialization:

Dematerialization is the process of converting physical share certificates into electronic form.

Opening a Demat Account:

An investor must first open a demat account with a Depository Participant (DP) by filling out an account opening form and submitting the required Know Your Customer (KYC) documents such as proof of identity, proof of address, and a PAN card.

DP provides the investor with a unique Beneficiary Owner Identification (BO ID) number, which is used to identify the account holder in all transactions.

Submission of Physical Certificates:
- After opening a demat account, the investor submits the physical share certificates they wish to dematerialize to the DP along with a Dematerialization Request Form (DRF).
- The DRF includes details such as the company’s name, the number of shares, and the certificate numbers.
Verification and Approval:
- The DP sends the physical certificates to the relevant company’s Registrar and Transfer Agent (RTA) for verification.
- Once verified, the RTA approves the dematerialization request, and the physical certificates are canceled.
Credit to the Demat Account:
- After the RTA’s approval, the depository (NSDL or CDSL) credits the corresponding number of shares to the investor’s demat account.
- The investor receives a notification confirming that the shares have been successfully dematerialized and credited to their account.
Trading of Dematerialized Securities:

After dematerialization, the shares can be bought, sold, and transferred electronically through the stock exchanges. Investors can monitor their holdings and transactions online, with settlement occurring in a shorter time frame (T+2 days, where T is the trading day).

Advantages of the Demat System:

Elimination of Physical Risks:

In the physical form, share certificates were vulnerable to theft, forgery, loss, and damage. The demat system eliminates these risks by holding securities electronically, ensuring safety and security.

Reduction in Paperwork:

Demat system removes the need for paperwork related to the issuance, transfer, and maintenance of share certificates. This reduces administrative burdens and streamlines the entire process for companies and investors alike.

Faster Settlement of Trades:

In the pre-demat era, transferring shares involved a lengthy process of physical delivery, verification, and approval, taking several weeks. Now, trades are settled electronically within two days (T+2 settlement), ensuring faster and more efficient transactions.

Lower Transaction Costs:

By eliminating physical transfers, the demat system reduces costs associated with paperwork, stamp duties, courier charges, and handling fees. Investors benefit from lower transaction costs, making trading more cost-effective.

Enhanced Liquidity:

Dematerialization has enhanced liquidity in the stock market. Shares held in electronic form can be quickly and easily traded, increasing market efficiency and providing investors with greater flexibility.

Access to a Broader Range of Securities:

Through a demat account, investors can hold a variety of securities, such as equity shares, bonds, debentures, government securities, mutual funds, and exchange-traded funds (ETFs), all in one place, offering convenience and diversification.

Transparency and Monitoring:

Investors can easily monitor their holdings, transactions, and portfolio through online access to their demat account. Real-time updates ensure transparency in the management of securities.

Simplified Pledging of Securities:

Securities held in a demat account can be pledged for loans, offering liquidity to investors. The dematerialized form makes it easier to pledge shares with financial institutions for credit or loan purposes.

Disadvantages of the Demat System:

Technological Dependency:

Demat system relies on technology, and any system failures or glitches can disrupt trading and access to accounts. Cybersecurity threats and hacking risks are also present in the digital environment.

Charges and Fees:

While the demat system reduces some costs, investors must pay account maintenance fees, transaction charges, and other service fees to the DP. These charges can add up over time, especially for small investors.

Loss of Paper Certificates:

Some investors may still prefer holding physical certificates for sentimental reasons or for tangible proof of ownership. The transition to a demat system eliminates the physical representation of ownership.

Fraud Risks:

Although the Demat system reduces physical fraud risks, it is not immune to other types of fraud, such as unauthorized access to demat accounts, hacking, or insider fraud.

Legal Framework for the Demat System in India

Depositories Act, 1996:

This act provides the legal framework for the establishment of depositories and facilitates the dematerialization of securities.

SEBI (Depositories and Participants) Regulations, 1996:

These regulations lay down the rules for the functioning of depositories and DPs.

SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015:

Companies listed on stock exchanges must ensure that their securities are available for trading in dematerialized form.

Composition of Board of Directors

by indiafreenotes16/07/202020/10/20241

Understanding your roles and responsibilities should be your first task when appointed. The board of directors is appointed to act on behalf of the shareholders to run the day to day affairs of the business. The board are directly accountable to the shareholders and each year the company will hold an annual general meeting (AGM) at which the directors must provide a report to shareholders on the performance of the company, what its future plans and strategies are and also submit themselves for re-election to the board.

The objects of the company are defined in the Memorandum of Association and regulations are laid out in the Articles of Association.

The board of directors’ key purpose is to ensure the company’s prosperity by collectively directing the company’s affairs, whilst meeting the appropriate interests of its shareholders and stakeholders. In addition to business and financial issues, boards of directors must deal with challenges and issues relating to corporate governance, corporate social responsibility and corporate ethics.

It is important that board meetings are held periodically so that directors can discharge their responsibility to control the company’s overall situation, strategy and policy, and to monitor the exercise of any delegated authority, and so that individual directors can report on their particular areas of responsibility.

Every meeting must have a chair, whose duties are to ensure that the meeting is conducted in such a way that the business for which it was convened is properly attended to, and that all those entitled to may express their views and that the decisions taken by the meeting adequately reflect the views of the meeting as a whole. The chair will also very often decide upon the agenda and might sign off the minutes on his or her own authority.

Individual directors have only those powers which have been given to them by the board. Such authority need not be specific or in writing and may be inferred from past practice. However, the board as a whole remains responsible for actions carried out by its authority and it should therefore ensure that executive authority is only granted to appropriate persons and that adequate reporting systems enable it to maintain overall control.

The chairman of the board is often seen as the spokesperson for the board and the company.

Appointment of directors

The ultimate control as to the composition of the board of directors rests with the shareholders, who can always appoint, and more importantly, sometimes dismiss a director. The shareholders can also fix the minimum and maximum number of directors. However, the board can usually appoint (but not dismiss) a director to his office as well. A director may be dismissed from office by a majority vote of the shareholders, provided that a special procedure is followed. The procedure is complex, and legal advice will always be required.

Roles of the board of directors

The roles of the board of directors include:

Establish vision, mission and values

Determine the company’s vision and mission to guide and set the pace for its current operations and future development.
Determine the values to be promoted throughout the company.
Determine and review company goals.
Determine company policies

Set strategy and structure

Review and evaluate present and future opportunities, threats and risks in the external environment and current and future strengths, weaknesses and risks relating to the company.
Determine strategic options, select those to be pursued, and decide the means to implement and support them.
Determine the business strategies and plans that underpin the corporate strategy.
Ensure that the company’s organizational structure and capability are appropriate for implementing the chosen strategies.
PEST and SWOT analyses
Determining strategic options
Strategies and plans

Delegate to management

Delegate authority to management, and monitor and evaluate the implementation of policies, strategies and business plans.
Determine monitoring criteria to be used by the board.
Ensure that internal controls are effective.
Communicate with senior management.

Exercise accountability to shareholders and be responsible to relevant stakeholders

Ensure that communications both to and from shareholders and relevant stakeholders are effective.
Understand and take into account the interests of shareholders and relevant stakeholders.
Monitor relations with shareholders and relevant stakeholders by gathering and evaluation of appropriate information.
Promote the goodwill and support of shareholders and relevant stakeholders.

Responsibilities of directors

Directors look after the affairs of the company, and are in a position of trust. They might abuse their position in order to profit at the expense of their company, and, therefore, at the expense of the shareholders of the company.

Consequently, the law imposes a number of duties, burdens and responsibilities upon directors, to prevent abuse. Much of company law can be seen as a balance between allowing directors to manage the company’s business so as to make a profit, and preventing them from abusing this freedom.

Directors are responsible for ensuring that proper books of account are kept.

In some circumstances, a director can be required to help pay the debts of his company, even though it is a separate legal person. For example, directors of a company who try to ‘trade out of difficulty’ and fail may be found guilty of ‘wrongful trading’ and can be made personally liable. Directors are particularly vulnerable if they have acted in a way which benefits themselves.

The directors must always exercise their powers for a ‘proper purpose’ – that is, in furtherance of the reason for which they were given those powers by the shareholders.
Directors must act in good faith in what they honestly believe to be the best interests of the company, and not for any collateral purpose. This means that, particularly in the event of a conflict of interest between the company’s interests and their own, the directors must always favour the company.
Directors must act with due skill and care.
Directors must consider the interests of employees of the company.

Calling a directors’ meeting

A director, or the secretary at the request of a director, may call a directors’ meeting. A secretary may not call a meeting unless requested to do so by a director or the directors. Each director must be given reasonable notice of the meeting, stating its date, time and place. Commonly, seven days is given but what is ‘reasonable’ depends in the last resort on the circumstances

Non-executive directors

Legally speaking, there is no distinction between an executive and non-executive director. Yet there is inescapably a sense that the non-executive’s role can be seen as balancing that of the executive director, so as to ensure the board as a whole functions effectively. Where the executive director has an intimate knowledge of the company, the non-executive director may be expected to have a wider perspective of the world at large.

The chairman of the board

The articles usually provide for the election of a chairman of the board. They empower the directors to appoint one of their own number as chairman and to determine the period for which he is to hold office. If no chairman is elected, or the elected chairman is not present within five minutes of the time fixed for the meeting or is unwilling to preside, those directors in attendance may usually elect one of their number as chairman of the meeting.

The chairman will usually have a second or casting vote in the case of equality of votes. Unless the articles confer such a vote upon him, however, a chairman has no casting vote merely by virtue of his office.

Since the chairman’s position is of great importance, it is vital that his election is clearly in accordance with any special procedure laid down by the articles and that it is unambiguously minuted; this is especially important to avoid disputes as to his period in office. Usually there is no special procedure for resignation. As for removal, articles usually empower the board to remove the chairman from office at any time. Proper and clear minutes are important in order to avoid disputes.

Role of the chairman

The chairman’s role includes managing the board’s business and acting as its facilitator and guide. This can include:

Determining board composition and organisation;
Clarifying board and management responsibilities;
Planning and managing board and board committee meetings;
Developing the effectiveness of the board.

Find out more about director development and training.

Shadow directors

In many circumstances, the law applies not only to a director, but to a ‘shadow director’. A shadow director is a person in accordance with whose directions or instructions the directors of a company are accustomed to act. Under this definition, it is possible that a director, or the whole board, of a holding company, and the holding company itself, could be treated as a shadow director of a subsidiary.

Professional advisers giving advice in their professional capacity are specifically excluded from the definition of a shadow director in the companies legislation.

Arbitrage in the APT

Arbitrage Pricing Theory

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Meaning of Remuneration

Role of Executive Remuneration

Interplay Between Fixed and Variable Component

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Incomes to be taxed under the head, ‘Capital Gains’

Important Definitions in capital gains

Meaning of Transfer [Section 2(47)]

Transactions which are not regarded as transfer [Section 47]

Full Value of Consideration

Cost of Acquisition

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Foreign currency cash flows:

Change in ownership (no such concept under AS 3):

Non-cash Transactions:

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Appointment of directors

Roles of the board of directors

Establish vision, mission and values

Set strategy and structure

Delegate to management

Exercise accountability to shareholders and be responsible to relevant stakeholders

Responsibilities of directors

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